Are you confused about the term closed-end credit and open-end credit? you are not alone. Join us as we take you through all that you need to know to clear your confusion.
As a broker, is very important that you understand the difference between the different types of credit and their accompanying loans to enable you to advise your borrowers on their best path towards homeownership.
Closed-End Credit
Closed-end credit is where the amount borrowed is provided to the borrower upfront. The credit is gotten for a particular purpose, and the borrower is expected to pay the entire loan, including the interest and maintenance fees, at the end of the set period.
When monthly installments are made, the balance owed to the lender keeps decreasing.
Secured Loans
Quite a number of mortgages are secured loans and require collateral. To act as collateral, or a guarantee that the debtors will pay back the loan in full, the borrower agrees to put up something valuable that belongs to them in order to forfeit if they breach the contract. Where it concerns a home loan or mortgage, this collateral is the home itself.
Other types of collateral can include a car, a sum that is invested in a savings account, or a certificate of deposit (CD). Now when collateral is added as a form of insurance to the transaction, the lender can afford to offer less aggressive rates and fees, even though this comes with a lot more risk to the borrower. You do not necessarily need a good credit score with a secured loan, but collateral is absolutely required.
Examples of Secured Loans:
- FHA Loans
- VA Loans
- Conventional Loans (Fannie Mae/Freddie Mac).
Unsecured Loan
An unsecured loan is one that does not require collateral. Howbeit, while an unsecured loan may sound good to the homebuyer, qualifying for one is often very difficult. Usually, the borrower may end up paying more in the long run. Since there is no security offered by collateral, the debtor’s eligibility and interest rates are more heavily influenced by their credit score. Rates Can be anywhere between 5% and 35% APR and they are typically scheduled to be repaid over the span of years at a time.
Where the borrower defaults on an unsecured loan, the lender does not have the right to claim the home. What this implies is that, even if the lender decides to sue, the borrower still has less risk of losing their home if they default. However, the underwriting standard for unsecured loans is much more detailed than that of a secured loan. Thus the borrower may need near-perfect credit in qualifying. Also, unsecured loans typically have shorter terms and higher monthly payments.
Open-End Credit
Open-end credit is a line of credit that may be used up to a specific preset limit. It is also known as revolving credit and includes several types.
Open-end credit operates differently. You qualify for an amount of money. One can borrow as little or as much of that money just as you prefer. Once you have paid your balance back, you can re-borrow the money, without negotiating the terms of your loan.
Examples of Open-End Credit
Here are examples of the different types of open-end credit:
- Home equity lines of credit, or HELOCs.
- Department store credit cards.
- Credit cards for the service station.
- Credit cards issued by banks.
- Overdraft protection for checking accounts.
Closed-end Credit vs. Open-end Credit
Both closed-end credit and open-end credit are different based on how funds are disbursed as well as how payments are made to the account. Closed-end credit is where the amount borrowed is provided to the borrower upfront. The credit is gotten for a purpose, and the borrower pays the entire loan, including the interest and maintenance fees, at the end of the set period.
When monthly deposits are made, the balance owed to the lender keeps decreasing. This is as opposed to open-end credit. In this case, the borrower can withdraw funds again after payment. In a closed-end, credit cannot be withdrawn a second time.
Open-end credit is better because it is not bound to a particular purpose. The borrower can access as much or as little money as they need as long as they make on-time payments to the account.
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